ESOP fables

Asia Business Law Journal

As the startup ecosystem in Asia matures, companies need high-quality talent to accelerate growth, but find their limited funding is only adequate to scale up operations, leaving fewer resources to hire and retain workers. This makes feasible a benefit plan that gives employees the right to purchase the company’s shares at a predefined or discounted price, called the employee stock ownership plan (ESOP).

Stock ownership has become a staple offering in developed economies and resulted in employees’ sudden wealth. When South Korean vaccine developer SK Bioscience went public on the local stock market last year, the company not only raised USD1.3 billion but also brought a fortune of KRW949.7 million (USD750,000) in share valuation for each employee invested in the ESOP, according to the local Maeil Business Newspaper.

Chae Jooyup, senior vice president of the Korea In-house Counsel Association (KICA), observes that many prominent lawyers have left law firms to join startups after being lured with stock options, granting a right to purchase a specific number of shares at a set price.

“The benefit of exercising those stock options could be greater than the monetary compensation,” says Chae. “Normally, the monetary compensation in a startup is lower than that of big law firms, but if you are willing to take the risk, then you may have a chance to make a lot of money by waiting for the stock price to rise.”

Chae explains that stock ownership plans may include stock options and restricted stock units, among others. The stock option is more common among Asian startups, while restricted stock units are mostly offered in big multinational companies, where employees receive company shares through a vesting plan and distribution schedule after achieving performance milestones or remaining for a particular time.

Many success stories can be found to highlight the advantage of stock ownership plans among startups, but the lack of clarity in legal frameworks has also resulted in confusion. In Vietnam last year, for example, Grab asked its former employees to give up their shares in exchange for a payout pegged to the company’s valuation before its IPO, as the country only allows current employees to own shares of foreign companies that employ them, as reported at news website Tech in Asia in late 2021.

Marshall Pribadi, CEO of digital signature provider PrivyID and chairman of the Indonesia Regtech and Legaltech Association in Jakarta, says that an ESOP is a good tool for employee retention when the employees can see the value of the company. An employee will not only be part of the company, but also an owner to some degree, which can be a great motivator.

However, “ESOPs should be an option, while in practice some companies are forcing their employees to purchase the company shares,” cautions Pribadi. “It’s not an option, but rather an obligation, where the company deducts a certain percentage from the employees’ monthly salary to buy the company shares.” Pribadi says this requirement is quite common among big startups in Asia, and is not an ideal situation.

Soft options

Zhang Guanglei, a partner at Jingtian & Gongcheng in Beijing, says the rationale behind ESOPs is to encourage employees to improve performance and stay with the company in the mid to long term, while benefitting from the company’s growth. If employees find this unappealing, they have the right to say no.

“Some companies are reported to require employees to participate in the ESOP, probably because the company is short of funds or wishes to keep their stock price up,” says Zhang. “From a legal perspective, there is no legal basis for companies to force employees to purchase the company’s stocks unless the employees agree.”

Zhang adds that employees should not be subject to any negative implications if they refuse to purchase the companies’ stocks, such as forced termination or a salary cut, which would be inconsistent with employment laws in China.

In South Korea, it’s not possible under the law to mandate an employee to purchase stock, says Chae, of SK Biopharmaceuticals. Although an ESOP may be offered to all employees, it is up to the employees whether or not to purchase the company’s shares.

“Employees may feel some pressure to purchase the stock, but a company cannot make them via a contract, or officially enforce that provision,” says Chae. He adds that ESOPs in South Korea are mandated by the Framework Act on Labour Welfare, which states that 20% of newly issued stocks must be allocated to the employees of the company when the company does an IPO.

“What is unique in Korea is that the representative director or registered directors are excluded from being recipients of the ESOP because they are deemed as the executives,” says Chae. “Other employees are given the ESOP according to their length of service. If someone works in a company for a longer period, he or she will get more rights to purchase the shares.”
Joe Choy, a senior associate at Mayer Brown in Hong Kong, says that most ESOPs do not mandate employees to purchase the company’s stock. A stock option provides a right, not an obligation, to purchase underlying stock, while a stock award is typically issued without charge.

“There may be some share purchase plans under which participating employees are required to use their own money to purchase the company’s stock, typically at a discounted price offered to them,” says Choy. “However, this is not the mainstream in Hong Kong and, even for these plans, the employees are generally allowed to elect whether to participate in the first place.”

While East Asian jurisdictions seem quite advanced in regulating equity compensation, a different scene prevails in Southeast Asia. Joel Shen, a partner in Singapore at Withers KhattarWong, which is affiliated with Withers, says the ESOP is not well understood as an employee incentive tool among startups in the region.

“The tech industry in Southeast Asia is very young compared to the more mature economies,” says Shen. “When North American companies like PayPal, Google and Facebook are listed on the stock market, many of their early employees became millionaires. However, there are very few unicorns in Southeast Asia that have gone public in the past few years where employees can exercise their stock options.”

When it comes to the legal framework, Shen adds there is no ESOP-specific regulation as the company laws of each jurisdiction already exist for regulating shares. To the extent of issuing options, contract laws are available to regulate that, as options are not shares or property but contracts.
Dang Hoan My, an associate at Indochine Counsel in Ho Chi Minh City, says Vietnamese laws do not require a joint stock company to put an ESOP in place before going public, nor provide any regulations for remedy in any issue arising when the employee exercises the stock option.

“Under the prevailing laws of Vietnam, an ESOP is entirely separate from wages and social welfare policies that are strictly required by law,” says Dang. “In theory, whether to purchase the company’s stock through an ESOP will be based upon the employee’s consideration and decision.”

In India, where the startup ecosystem flourishes, Cyril Amarchand Mangaldas’ partner in Bengaluru, Bharath Reddy , says that ESOPs are prevalent because private equity and venture capital firms make it mandatory for companies to have an ESOP programme in place prior to their investment.
Although Indian law does not mandate the issuance of an ESOP, Reddy says unlisted companies are required to comply with the Companies Act, 2013, and the Companies (Share Capital and Debentures) Rules, 2014, while listed companies are required to comply with the Securities Exchange Board of India (Share Based Employee Benefits and Sweat Equity) Regulations, 2021, for the issuance and implementation of an ESOP.

The Companies Act, 2013 read with the Companies (Share Capital and Debentures) Rules, 2014, set out the treatment of an ESOP when an individual ceases to be an employee of the company, and prohibit companies from varying their terms to the detriment of the interests of the ESOP holders. The 2021 regulations issued by the Securities Exchange Board of India govern all share-based employee benefit schemes dealing in securities, including employee stock options, employee share purchase, stock appreciation rights, general employee benefits and retirement benefits.

“Certain sector-specific regulators, such as in the banking and insurance sectors, have additional conditions for companies to comply with,” says Reddy. “These laws, aimed at protecting the interests of the ESOP holders, regulate the implementation by companies.”

Apart from an ESOP, Reddy explains that Indian startups also adopt other equity-linked compensation schemes, such as stock appreciation rights that entitle an employee to receive appreciation in shares or cash, and restricted stock units, where the stock options are granted at the minimum price under law.

“Most Indian startups prefer cash-settled stock appreciation rights, where the appreciation in the shares is paid out to the employee in cash, as they are unregulated and allow the company to compensate the employees without altering their share capital table,” says Reddy.

Bird in hand

Although many companies have initiated employee benefits plans aimed to retain talent, Chae observes that employee retention ironically becomes a challenge after the company completes a successful IPO.

“There is a restriction called a lock-up period for one year from the IPO, where the selling of stocks is prevented,” says Chae. “But if the employees want to avoid that restriction and make money by selling their stock, they can just leave the company. The company cannot prevent the employee from selling the stock if the employee leaves.”
Chae adds that if the stock was given by the company to the employees for free, the company can prevent the selling of stock even if the employees leave, or the company can forfeit the stock if the employees do not fulfil their obligations. But if the stock is purchased by an employee, it is the employee’s private asset, so the company cannot make it void.

He says that an ESOP is not always optimal for retaining employees or attracting new talent, especially when the expectation for the stock market is very low. Some employees might not be happy to receive an ESOP because the stock price is lower than the IPO price.
Trisula Dewantara, general counsel at Indonesia’s e-commerce platform Tokopedia in Jakarta, sees the biggest issue for employees in exercising their ESOP is in understanding their rights.

“A great company would have done a great job in communicating the benefit of an ESOP – what are the ultimate goals and gains, employees’ eligibility, and how to exercise [the benefit] in the future,” says Dewantara. “Another issue is understanding what it means for employees to exercise, do employees need to pay? If yes, what is the formula, and what is the impact on the personal tax status of the employees?”

As tax impacts differs for each individual, employees must equip themselves with the requisite knowledge and seek professional advice if necessary.

Shen, of Withers KhattarWong, highlights the tax position of employees as a common issue in an ESOP. As companies become larger and start hiring employees across multiple jurisdictions, the tax analysis becomes more complicated. For example, if an employee is required to pay 30% of the value of his or her ESOP in cash to the tax authority, even before selling the shares, the employee will be discouraged from participating.

“Different countries have different tax treatments for ESOPs and some countries have developed their tax law articulated for this,” says Shen. “In Singapore, where income is taxed but no tax for capital gains, the authority has extended its tax law to apply specifically to ESOPs.”

A similar issue can also be found in India. Reddy admits that one of the most common issues for employees in exercising their ESOPs is the cash outflow at the time of exercise. “Upon exercise of an ESOP, the employee is required to pay the exercise price and bear the perquisite tax, which can be around 30% to 42% of the upside,” says Reddy.

While the exercise price is predetermined at the time of the grant, ranging from face value to fair market value, the employee is also required to pay tax on the perquisite value, i.e., tax on the difference between the fair market value of the shares on the date of exercise and the exercise price.

“In addition to the perquisite tax, once the employee becomes a shareholder, they incur an additional tax on capital gains if they sell their shares at a profit,” says Reddy.
When it comes to disputes, Zhang, of Jingtian & Gongcheng, observes conflict often arises after employees exit from a company, largely because, as a mid to long-term retention incentive, the ESOP usually treats participants differently depending on their contracts.

“Typical ESOP disputes include those over the cancellation, forfeiture or encashment of share grant or option grant, repurchase of shares from ex-employees, confirmation of shareholder status, and many more,” says Zhang.

He also notes that employees may find it difficult to exercise or enforce their stock ownership rights due to a lack of uniform rules and jurisprudence in this regard. For example, courts may have different views on whether ESOP claims should be classified as labour disputes or contractual disputes, which are subject to different legal frameworks and procedures.

“Sometimes, the employee’s ESOP claim against the employer is rejected because the company granting shares or share options is not the employer, or because the incentive share is held by a third person by proxy agreement,” says Zhang.

Secret formulas

Finding the ideal type of ESOP is the main challenge for a company. As there is no golden rule on employee benefit plans, each company should use its own “flavour” that works for its specific needs and culture.

“If the company has the correct programme, and sets aside a realistic stock option pool, once the company is ready to fundraise to external parties bona fide investors would have no problem seeing the benefit of the programme,” says Dewantara, of Tokopedia. “It goes back to the whole employee retention goal, and investors coming into a company would want the founders, and great talent, to stay after their investment.”

For Pribadi, of PrivyID, choosing the right employee to be granted equity compensation can be perplexing. The company wants to give the shares only to the employees who are really giving their best, but it is hard to tell in the beginning and the company will still offer the ESOP anyway.

“There are some cases where the company gives the ESOP, but the employees are not contributing as expected or are not loyal to the company,” says Pribadi. “Sometimes the employees even ask to have the stock upfront when joining the company without waiting for a vesting period.”

Pribadi says that the success of equity compensation depends on the “rules of the game”. Some companies allow employees who resign to exercise the benefit of their ESOP. This employee may not be able to hold the shares, but the company will buy them in cash with the current stock price, or the price on the day the employee resigns, although the rules are generally different from one company to another.

Balancing management versus economic rights is another challenge, says Shen. Productive, incentivised and motivated employees are good for the company, but a misalignment can happen when the employees become shareholders and inadvertently have management rights.

“The company should think about drafting and administering an ESOP in a way that allows the employees to enjoy economic growth without necessarily having to participate in the company’s management,” says Shen. “The intention was not for them to come to shareholder meetings and to question about how the CEO is running the company, but to have them benefit when the company commences an IPO.”

Zhang also notes compliance issues, source of incentive shares, pricing and allocation of share grants, and treatment of shares or share options after the employees’ termination of employment are among the main challenges for companies implementing an ESOP.

“Sometimes, employees’ benefits conferred by the ESOP could be at odds with the investors’ interest if, for example, the terms of the grant are unreasonably favourable to certain employees,” says Zhang. “Companies may avoid such conflict by increasing the level of compliance and transparency when designing and implementing the ESOP.”

For example, he says the China Securities Regulatory Commission requires listed companies to follow a set of procedures for drafting, deliberation and implementing their ESOPs, including the approval of the board and shareholders. For unlisted companies, the implementation of an ESOP shall also comply with the deliberation rules prescribed by its articles of association and internal policies.
Jeckle Chiu, corporate and securities partner at Mayer Brown in Hong Kong, says one of the key challenges for startup companies is valuating ESOP rights when there is not yet a public market for the company’s stock.

“There may be a misalignment in the perception of the employee share value between the company and its employees,” says Chiu. “This hinders the company’s ability to maximise the intended effect of an ESOP in attracting and retaining talent. It also creates a material cost burden for the company when there is a need to value the ESOP rights before a liquidity event.”

Such an event might happen if an employee cashes out vested options or shares on cessation of employment under a particular plan.

Another challenge, says Chiu, is determining the appropriate size of the option or share pool for ESOP purposes. As there is no hard and fast rule, the pool size will depend on the circumstances of the particular company, and finding the right size is key to balancing the employee benefit to attract the best talent while keeping investor interest.


As a tool to provide long-term incentive, a company normally implements an ESOP before going public or receiving an investment round. Trisula Dewantara, general counsel at Indonesia’s e-commerce platform Tokopedia in Jakarta, argues that having an ESOP in the early stages makes sense because the company is privately held and its actual shares are not tradable.

“It is a useful tool to make ultimate alignment for all levels within the company, as they will benefit more when the company scales and increase in value,” says Dewantara. “It is important to have a correct ESOP system in place from as early as possible, because a company needs to attract and maintain its best talent.”

Joel Shen, a partner at Withers KhattarWong in Singapore, agrees that many startups want to hire incredibly talented people, but cannot pay the same salaries as big techs. “In startups, ESOPs are usually drafted before the company completed its first institutional round of fundraising. If a startup wants to raise money from an institutional or a venture capital investor, the investors will ask the startup to set up an ESOP pool for 10% or 15% of the company shares before the investment goes in.”

The reason is that the VC doesn’t want its money diluted by the ESOP. During that phase, only a few startups have in-house counsel who are equipped to draft an ESOP. These companies might be several months or one year old, and their money is usually spent on developing the product or scaling up the business, but not to hiring a dedicated in-house legal function.

“Therefore in my experience, 99.9% of the time, the ESOP contract is drafted by an external lawyer,” says Shen.

Jeckle Chiu, a partner at Mayer Brown in Hong Kong, says it is important for a company to implement an ESOP before securing investors for various reasons. Some investment funds may actually expect an ESOP to be in place before investing in a company to make sure that the company’s senior talent and executive team members are appropriately resourced.

“Having an ESOP in place before an investment comes in also provides the investor with certainty in relation to any potential dilution in the future,” says Chiu. “A relatively more established private company that is about to go IPO, and which has not previously set up an ESOP, may also adopt a pre-IPO ESOP to reward long-serving employees.”
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